June 19, 2018 1

Rating: BUY | CMP: Rs266 | TP: Rs346

Valuations reflect FEAR rather than recovery

We reiterate BUY on ITC given that the stock is available at 22.4x FY20 EPS

(50% discount to large cap consumer names) and offers 2% dividend yield

due to FEAR related to cigarette tax increases. However, we expect relatively

moderate increase in cigarette taxes in medium term given 1) Rs200bn

surplus and robust compensation cess collections in April and May 2018 and

2) 18-40% advalorem component in cigarette GST. We estimate 3% volume

growth and double digit EBIT growth in cigarettes given low base and

improved product mix. (FY18, 6.6% EBIT growth on 3.3% volume decline).

FMCG business is on cusp of sharp improvement in profits (est 2x growth in

3 years) given rising scale and peaked out losses in personal care and

Lifestyle retailing. Paperboard business is expected to improve margins

given benign input costs, benefits from refurbishment of Décor machine and

expected capacity expansion. We expect higher ARR and occupancy rates to

improve profitability in Hotels. Lower production and high prices of leaf

tobacco in India will drag Agri business, despite some relief from INR

depreciation. Retain “Buy” with SOTP based target price of Rs346.

Compensation cess collections healthy: Central Govt. collected Rs620bn

as compensation cess on SIN goods in FY18 (Est 411bn) and is thus sitting on

surplus of Rs200bn. FY19 budget target is Rs611bn while the collections in

April and May have been Rs159bn (Rs143bn excluding imports) which

alleviates any urgency to increase compensation cess. We expect little or

moderate change in taxes on cigarettes in the current year.

Estimate 3% Cigarette volume growth in FY19: ITC’s cigarette volumes had

declined ~2.5% in 4Q (7% in 2Q and 5% in 3Q), we expect 1Q volumes to be

flattish to slightly negative. Although RSFT and KSFT had seen brunt of volume

pressure, KSFT has now stabilized. We expect gradual mix improvement in

coming quarters given increasing discretionary spends in the economy. We

estimate 3% volume growth in FY19.

FMCG profitability expected to improve: ITC reported sales and EBIT of

Rs113bn and Rs1.64bn in FY18 as margins increased 118bps to 1.4%. We

expect margin expansion to sustain in coming years led by 1) lower drag from

incubation businesses in foods 2) likely reduction in personal care losses

significantly given success of new innovations and cost cutting 3) lower losses

in Lifestyle retailing as ITC has already taken major part of pain. We estimate

FMCG EBIT to increase to Rs5.3bn by FY20.

Hotels and Paperboard on recovery path, INR depreciation positive for

Leaf Tobacco; Hotels business is reporting improved ARR and robust growth

in F&B and is on steady recovery. Paperboard business is getting the benefit

of using higher in-house pulp (33% v/s 25% earlier) and cheaper inputs despite

pressure on user industries. Expected pickup in cigarettes and FMCG will

improve margins from current levels. Agri Business sales decline 2.3% EBIT

declined 6.4% as higher leaf tobacco prices, lower output and quality due to

drought in AP and strong currency curtailed exports. Higher wheat production

in Russia and lower domestic surplus also limited trading opportunities.

However, INR depreciation is expected to provide support to leaf tobacco

exports in FY19.

ITC (ITC IN)

June 19, 2018

Company Update

☑ Change in Estimates | Target | Reco

Change in Estimates

Current Previous

FY19E FY20E FY17E FY18E

Rating BUY BUY

Target Price 346 346

Sales (Rs.m) 4,71,122 5,12,342 4,72,132 5,13,403

% Chng. (0.2) (0.2)

EBITDA (Rs.m) 1,81,182 2,04,852 1,82,105 2,04,811

% Chng. (0.5) (0.0)

EPS (Rs.) 10.5 11.9 10.5 11.8

% Chng. - 0.8

Key Financials

FY17 FY18 FY19E FY20E

Sales (Rs. bn) 401 406 471 512

EBITDA (Rs. bn) 146 155 181 205

Margin (%) 36.4 38.3 38.5 40.0

PAT (Rs. bn) 102 112 128 147

EPS (Rs.) 8.4 9.2 10.5 11.9

Gr. (%) (27.6) 9.5 13.7 13.7

DPS (Rs.) 4.7 5.2 6.2 6.8

Yield (%) 1.8 1.9 2.3 2.6

RoE (%) 23.5 23.2 23.8 24.7

RoCE (%) 35.7 34.2 36.1 37.3

EV/Sales (x) 7.7 7.7 6.6 6.0

EV/EBITDA (x) 21.3 20.1 17.1 15.0

PE (x) 31.7 28.9 25.4 22.4

P/BV (x) 7.1 6.3 5.8 5.2

Key Data ITC.BO | ITC IN

52-W High / Low Rs.368 / Rs.250

Sensex / Nifty 35,287 / 10,710

Market Cap Rs.3,247bn/ $ 47,541m

Shares Outstanding 12,203m

3M Avg. Daily Value Rs.5143.33m

Shareholding Pattern (%)

Promoter’s -

Foreign 18.00

Domestic Institution 37.10

Public & Others 44.90

Promoter Pledge (Rs bn)

Stock Performance (%)

1M 6M 12M

Absolute (5.8) 0.7 (14.4)

Relative (6.9) (3.5) (24.1)

Amnish Aggarwal

amnishaggarwal@plindia.com | 91-22-66322233

Nishita Doshi

nishitadoshi@plindia.com | 91-22-66322381

ITC

June 19, 2018 2

Q4FY18 Result Overview (Rs m); Overall Sales down 4.8%, Adj. PAT up 9.9%

Y/e March Q4FY18 Q4FY17 YoY gr. (%) Q3FY18 FY18 FY17 YoY gr. (%)

Net Sales 1,05,867 1,11,255 (4.8) 97,720 4,06,275 4,00,887 1.3

EBITDA 41,440 38,754 6.9 39,045 1,55,564 1,45,780 6.7

Margins (%) 39.1 34.8 4.3 40.0 38.3 36.4 1.9

Depreciation 3,040 2,418 25.7 2,908 11,454 10,380 10.3

Interest 232.4 (114.6) (302.8) 240 867 230 277.6

Other Income 5,165 4,021 28.5 6,269 21,144 19,859 6.5

PBT 43,333 40,471 7.1 42,167 1,64,388 1,55,030 6.0

Tax 14,006 13,777 1.7 13,965 54,856 53,021 3.5

Rate (%) 32.3 34.0 (1.7) 33.1 33.4 34.2 (0.8)

Adj. PAT 29,327 26,695 9.9 28,202 1,09,533 1,02,009 7.4

Source: Company, PL

Cigarettes are 42.9% of Sales, FMCG 26.5%

Cigarettes42.9%

FMCG 26.5%

Hotels3.5%

Agri business

15.7%

Paper and packaging

11.3%

Source: Company, PL

Cigarettes are 86.8% of EBIT

Cigarettes86.8%

FMCG 2.3%

Hotels1.9%

Agri business

3.1%

Paper and packaging

6.0%

Source: Company, PL

Cigarettes: Volumes down ~2.5%, QoQ recovery visible

-14

-12

-17

-14.5

-4

0.5

3 3.5

-0.5

01.5

-7

-5

-2.5

-20

-15

-10

-5

0

5

3Q

FY

15

4Q

FY

15

1Q

FY

16

2Q

FY

16

3Q

FY

16

4Q

FY

16

1Q

FY

17

2Q

FY

17

3Q

FY

17

4Q

FY

17

1Q

FY

18

2Q

FY

18

3Q

FY

18

4Q

FY

18

Source: Company, PL

Cigarette Volumes recovery

underway, 64mm 38% of volumes

Mix has stabilized, expect growth to

resume in KSFT given stable taxes

and prices and improved

discretionary spends

Expect stable taxes given strong

trends in compensation Cess

collection, EBIT grew by 6.6% in

FY18 despite severe pressure on all

fronts

ITC

June 19, 2018 3

FMCG profits at all-time high; Hotels on steady recovery path

4QFY17 1QFY18 2QFY18 3QFY18 4Q18

Cigarette Volume Growth % 0.0 1.5 -7.0 -5.0 -2.5

Sales (INR m) 1,17,128 1,15,503 1,09,359 1,07,159 1,15,054

Cigarettes 51,493 45,242 45,542 46,292 49,365

FMCG 28,858 26,009 28,041 28,718 30,518

Hotels 3,865 3,049 3,002 4,044 4,080

Agri business 19,185 27,605 19,680 15,309 18,083

Paper and packaging 13,727 13,598 13,094 12,796 13,008

Sales growth (YoY)

Cigarettes (39.7) (45.0) (2.1) 14.2 (4.1)

FMCG 6.5 9.0 5.0 11.8 5.8

Hotels 6.5 6.1 1.0 9.2 5.6

Agri business 6.2 (1.2) 4.7 (8.4) (5.7)

Paper and packaging 4.4 2.8 4.6 (4.2) (5.2)

EBIT (INR m) 37,563 37,773 38,468 38,726 40,388

Cigarettes 32,588 32,741 32,917 32,693 35,058

FMCG 556 54 205 470 912

Hotels 669 53 42 548 755

Agri business 1,349 2,351 2,562 2,333 1,240

Paper and packaging 2,402 2,573 2,742 2,683 2,424

EBIT growth (YoY) 6.9 8.3 2.8 9.4 7.5

Cigarettes 8.0 9.0 2.3 7.8 7.6

FMCG (29.3) 220.1 728.5 339.0 64.2

Hotels 56.9 335.2 552.3 29.9 12.8

Agri business (20.8) (0.9) (13.7) (1.4) (8.1)

Paper and packaging 18.3 3.9 18.2 9.0 0.9

EBIT Margin (%)

Cigarettes 63.3 72.4 72.3 70.6 71.0

FMCG 1.9 0.2 0.7 1.6 3.0

Hotels 17.3 1.7 1.4 13.5 18.5

Agri business 7.0 8.5 13.0 15.2 6.9

Paper and packaging 17.5 18.9 20.9 21.0 18.6

Source: Company, PL

We have estimates net sales for 4QFY17 based on the excise duty trends in

cigarettes and various other products

Packagd food business has stabilised

Instant Noodles market share at 24-

25% and leadership in Bingo Tedhe

Medhe.

Premium Biscuits continue to do well,

creams growth has slowed down.

Coffee and Premium Chocolates are

new growth frontiers, Dairy is a

challenging business given indian

conditions.

Engage is clear No2 with 10-11%

share and Savlon is rapidly gaining

share in liquid handwash.

ITC has entered Home care with

acquisition of Nimyle brand of floor

cleaners which has presence in West

bengal and Odisha.

Paper should benefit from higher in-

house pulp, lower inputs and

expected incraese in demand from

FMCG and Cigarette business

Hotels business revenue increased

due to higher ARR and recovery in

F&B revenues post resolution of

highway ban issue. ITC has started

operations at ITC Kohenur, a luxury

collection property at Hyderabad

INR depreciation is expected to

restore lost competitiveness of Indian

Leaf tobacco and improve

performance in FY19.

ITC

June 19, 2018 4

Financials

Income Statement (Rs m)

Y/e Mar FY17 FY18 FY19E FY20E

Net Revenues 4,00,887 4,06,275 4,71,122 5,12,342

YoY gr. (%) 9.6 1.3 16.0 8.7

Cost of Goods Sold 1,59,763 1,57,991 1,76,636 1,94,907

Gross Profit 2,41,124 2,48,285 2,94,486 3,17,435

Margin (%) 60.1 61.1 62.5 62.0

Employee Cost 24,443 24,865 27,573 28,486

Other Expenses 37,189 35,491 46,069 44,584

EBITDA 1,45,781 1,55,409 1,81,182 2,04,852

YoY gr. (%) 6.3 6.6 16.6 13.1

Margin (%) 36.4 38.3 38.5 40.0

Depreciation and Amortization 10,380 11,454 12,167 13,033

EBIT 1,35,400 1,43,956 1,69,015 1,91,819

Margin (%) 33.8 35.4 35.9 37.4

Net Interest 230 867 674 674

Other Income 19,859 21,298 25,102 29,904

Profit Before Tax 1,55,030 1,64,388 1,93,443 2,21,049

Margin (%) 38.7 40.5 41.1 43.1

Total Tax 53,021 52,156 65,190 74,493

Effective tax rate (%) 34.2 31.7 33.7 33.7

Profit after tax 1,02,009 1,12,232 1,28,253 1,46,555

Minority interest - - - -

Share Profit from Associate - - - -

Adjusted PAT 1,02,009 1,12,232 1,28,253 1,46,555

YoY gr. (%) 9.4 10.0 14.3 14.3

Margin (%) 25.4 27.6 27.2 28.6

Extra Ord. Income / (Exp) - - - -

Reported PAT 1,02,009 1,12,232 1,28,253 1,46,555

YoY gr. (%) 9.4 10.0 14.3 14.3

Margin (%) 25.4 27.6 27.2 28.6

Other Comprehensive Income 770 3,823 - -

Total Comprehensive Income 1,02,779 1,16,056 1,28,253 1,46,555

Equity Shares O/s (m) 12,147 12,204 12,264 12,324

EPS (Rs) 8.4 9.2 10.5 11.9

Source: Company Data, PL Research

Balance Sheet Abstract (Rs m)

Y/e Mar FY17 FY18 FY19E FY20E

Non-Current Assets

Gross Block 2,46,939 2,64,880 2,84,993 3,05,193

Tangibles 2,38,962 2,56,266 2,76,179 2,96,179

Intangibles 7,977 8,614 8,814 9,014

Acc: Dep / Amortization 97,680 1,09,133 1,21,299 1,34,332

Tangibles 93,812 1,04,979 1,16,855 1,29,590

Intangibles 3,868 4,154 4,445 4,742

Net fixed assets 1,49,259 1,55,748 1,63,694 1,70,861

Tangibles 1,45,150 1,51,287 1,59,324 1,66,589

Intangibles 4,109 4,460 4,369 4,272

Capital Work In Progress 34,913 50,169 30,000 30,000

Goodwill - - - -

Non-Current Investments 85,912 1,35,012 1,40,710 1,46,978

Net Deferred tax assets (18,717) (19,179) (20,138) (21,145)

Other Non-Current Assets 26,701 37,669 30,623 33,302

Current Assets

Investments 1,00,998 99,035 1,28,435 1,71,152

Inventories 78,640 72,372 94,721 1,03,039

Trade receivables 22,075 23,570 26,240 27,848

Cash & Bank Balance 27,473 25,949 27,999 30,175

Other Current Assets 6,106 12,584 7,067 7,685

Total Assets 5,42,160 6,23,627 6,62,160 7,34,976

Equity

Equity Share Capital 12,147 12,204 12,264 12,324

Other Equity 4,41,262 5,01,796 5,49,667 6,14,731

Total Networth 4,53,410 5,14,001 5,61,932 6,27,055

Non-Current Liabilities

Long Term borrowings 180 111 53 -

Provisions 1,314 1,219 1,471 1,550

Other non current liabilities 147 383 421 463

Current Liabilities

ST Debt / Current of LT Debt 0 0 0 0

Trade payables 25,512 33,823 28,191 30,431

Other current liabilities 42,788 54,557 49,566 53,903

Total Equity & Liabilities 5,42,160 6,23,627 6,62,160 7,34,976

Source: Company Data, PL Research

ITC

June 19, 2018 5

Cash Flow (Rs m)

Y/e Mar FY17 FY18 FY19E FY20E Year

PBT 1,55,030 1,64,388 1,93,443 2,21,049

Add. Depreciation 10,380 11,454 12,167 13,033

Add. Interest 230 867 674 674

Less Financial Other Income 19,859 21,298 25,102 29,904

Add. Other (10,403) (12,903) (7,097) (10,000)

Op. profit before WC changes 1,55,236 1,63,805 1,99,186 2,24,756

Net Changes-WC (7,056) 19,095 (59,394) (46,783)

Direct tax (53,021) (52,156) (65,190) (74,493)

Net cash from Op. activities 95,160 1,30,744 74,602 1,03,480

Capital expenditures (30,252) (33,197) 55 (20,200)

Interest / Dividend Income - - - -

Others (8,964) (42,639) (16,063) (8,945)

Net Cash from Invt. activities (39,215) (75,836) (16,007) (29,145)

Issue of share cap. / premium 26,976 13,295 19,925 20,195

Debt changes (114) (69) (59) (53)

Dividend paid (81,736) (69,447) (75,737) (91,627)

Interest paid (230) (867) (674) (674)

Others - - - -

Net cash from Fin. activities (55,104) (57,087) (56,544) (72,159)

Net change in cash 841 (2,178) 2,051 2,176

Free Cash Flow 64,908 97,547 74,658 83,280

Source: Company Data, PL Research

Quarterly Financials (Rs m)

Y/e Mar Q1FY18 Q2FY18 Q3FY18 Q4FY18

Net Revenue 99,547 1,03,141 97,720 1,05,867

YoY gr. (%) (1.0) 6.8 5.7 (4.8)

Raw Material Expenses 38,360 43,564 35,810 40,012

Gross Profit 61,187 59,578 61,910 65,855

Margin (%) 61.5 57.8 63.4 62.2

EBITDA 37,464 37,615 39,045 41,440

YoY gr. (%) (3.3) 0.4 3.8 6.1

Margin (%) 37.6 36.5 40.0 39.1

Depreciation / Depletion 2,682 2,824 2,908 3,040

EBIT 34,782 34,791 36,138 38,400

Margin (%) 34.9 33.7 37.0 36.3

Net Interest 104 290 240 232

Other Income 4,768 4,942 6,269 5,165

Profit before Tax 39,446 39,443 42,167 43,333

Margin (%) 39.6 38.2 43.2 40.9

Total Tax 13,841 13,045 13,965 14,006

Effective tax rate (%) 35.1 33.1 33.1 32.3

Profit after Tax 25,605 26,398 28,202 29,327

Minority interest - - - -

Share Profit from Associates - - - -

Adjusted PAT 25,605 26,398 28,202 29,327

YoY gr. (%) 7.4 5.6 6.6 9.9

Margin (%) 25.7 25.6 28.9 27.7

Extra Ord. Income / (Exp) - - 2,700 -

Reported PAT 25,605 26,398 30,902 29,327

YoY gr. (%) 7.4 5.6 16.8 9.9

Margin (%) 25.7 25.6 31.6 27.7

Other Comprehensive Income 1,568 (290) 869 1,677

Total Comprehensive Income 27,173 26,108 31,771 31,004

Source: Company Data, PL Research

Key Financial Metrics

Y/e Mar FY17 FY18 FY19E FY20E

Per Share(Rs)

CEPS 9.3 10.1 11.4 12.9

BVPS 37.3 42.1 45.8 50.9

FCF 5.3 8.0 6.1 6.8

DPS 4.7 5.2 6.2 6.8

Return Ratio(%)

Core RoCE 44.1 40.1 44.3 48.8

RoCE 35.7 34.2 36.1 37.3

ROIC 26.9 24.9 27.4 27.9

RoE 23.5 23.2 23.8 24.7

Balance Sheet

Net Debt : Equity (x) (0.3) (0.2) (0.3) (0.3)

Net Working Capital (Days) 68 56 72 72

Valuation(x)

PER 31.7 28.9 25.4 22.4

P/B 7.1 6.3 5.8 5.2

P/CEPS 9.3 10.2 11.5 13.0

EV/EBITDA 21.3 20.1 17.1 15.0

EV/Sales 7.7 7.7 6.6 6.0

Dividend Yield (%) 1.8 1.9 2.3 2.6

Source: Company Data, PL Research

ITC

June 19, 2018 6

Price Chart Recommendation History

No. Date Rating TP (Rs.) Share Price (Rs.)

1 04-Jul-17 BUY 400 342

2 11-Jul-17 BUY 400 333

3 18-Jul-17 BUY 370 326

4 27-Jul-17 BUY 370 289

5 09-Oct-17 BUY 370 266

6 27-Oct-17 BUY 333 269

7 10-Jan-18 BUY 333 271

8 20-Jan-18 BUY 333 274

9 12-Feb-18 BUY 333 271

10 15-Mar-18 BUY 333 266

11 13-Apr-18 BUY 333 261

12 16-May-18 BUY 346 286

13 23-May-18 BUY 346 279

Analyst Coverage Universe

Sr. No. CompanyName Rating TP (Rs) Share Price (Rs)

1 Asian Paints Accumulate 1234 1215

2 Avenue Supermarts Reduce 1003 1490

3 Britannia Industries BUY 6170 5596

4 Colgate Palmolive Reduce 1075 1208

5 Dabur India Accumulate 377 371

6 Emami Accumulate 1154 1086

7 Future Retail BUY 627 608

8 GlaxoSmithKline Consumer Healthcare Accumulate 6800 5919

9 Hindustan Unilever Accumulate 1627 1573

10 ITC BUY 346 279

11 Jubilant FoodWorks Accumulate 2870 2560

12 Kansai Nerolac Paints BUY 526 506

13 Manpasand Beverages BUY 500 409

14 Marico Accumulate 313 312

15 Nestle India UR 0 8692

16 Pidilite Industries Accumulate 1175 1139

17 Titan Company BUY 1114 915

18 Tribhovandas Bhimji Zaveri Accumulate 120 106

PL’s Recommendation Nomenclature (Absolute Performance)

BUY : > 15%

Accumulate : 5% to 15%

Hold : +5% to -5%

Reduce : -5% to -15%

Sell : < -15%

Not Rated (NR) : No specific call on the stock

Under Review (UR) : Rating likely to change shortly

191

231

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5

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6

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-18

(Rs)

ITC

June 19, 2018 7

ANALYST CERTIFICATION

(Indian Clients)

We/I, Mr.Amnish Aggarwal- MBA, CFA, Ms.Nishita Doshi- CA, CFA Level 1, B.Com Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report.

(US Clients)

The research analysts, with respect to each issuer and its securities covered by them in this research report, certify that: All of the views expressed in this research report accurately reflect his or her or their personal views about all of the issuers and their securities; and No part of his or her or their compensation was, is or will be directly related to the specific recommendation or views expressed in this research report.

DISCLAIMER

Indian Clients

Prabhudas Lilladher Pvt. Ltd, Mumbai, India (hereinafter referred to as “PL”) is engaged in the business of Stock Broking, Portfolio Manager, Depository Participant and distribution for third party financial products. PL is a subsidiary of Prabhudas Lilladher Advisory Services Pvt Ltd. which has its various subsidiaries engaged in business of commodity broking, investment banking, financial services (margin funding) and distribution of third party financial/other products, details in respect of which are available at www.plindia.com.

This document has been prepared by the Research Division of PL and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of PL. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security.

The information contained in this report has been obtained from sources that are considered to be reliable. However, PL has not independently verified the accuracy or completeness of the same. Neither PL nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein.

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